Author Topic: Pulling money out of the market now to lend hard money  (Read 2866 times)

goodday,eh

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Pulling money out of the market now to lend hard money
« on: September 06, 2018, 09:52:20 PM »
Hi, long time reader, first time poster.  I'm wrestling something in my head and nobody in my real life circle could relate to this issue so I'm hoping for some guidance.

The question:  Should I pull money out of the market now to invest in a hard money loan with a trusted friend and how much is too much?

Facts:

My friend invests in a lot of real estate and he's able to find deals through his network of wholesalers, etc.  But, he can't always pull the trigger when he wants because going through the bank is a painful process and other hard money lenders can have hefty points or prepayment penalties built into their loans. 

We were talking and i have money in the market and i'm uneasy about the next twelve months and wouldn't mind diversifying.  I have about $500k in aftertax money in stocks and another $300k in pretax.  This doesn't include emergency savings, yada yada.  I'm 7 years away from FI, and make a good income so i can ride out a downturn if need be.  But, he offered to pay 10% interest only if i wanted to finance any deals and I would take 10% guaranteed any day of the week over market uncertainty. 

The deal would include no prepayments penalties or points.  The loans would be secured by the properties and I do trust him 100% (or as close as you can trust anybody).  I'm a CPA and do his taxes and know he has a net worth of close to $2 million but it's all tied up in properties (he has around 20 and was buying at the right time).  He'll provide the property addresses and contracts so i know what's securing the loans.  I live in Tampa and our market is still very strong and he finds incredible deals.  While deals may mean risk, he's not a flipper.  He rents them all out and will refi it once its rehabbed and rented and then pay me back my principal within 6 months to 12 months.  At that point, i'd either fund another deal or put it back in the market.

I'm open to doing a deal and was ready to pull the trigger on a $100k loan.  Now he has two deals that would total around $200k.  There's no pressure from him.  I can do both, one, or none.  Won't impact our relationship at all.  It saves him money from having to deal with the other guys, and i get an almost guaranteed 10% return while I'm very uneasy about the market.  However, that would be 40% of my aftertax investments tied up in something i have no experience with.  That's not diversification.

So, back to the question.  Am I an idiot for considering this at all?  Am I an idiot for not jumping on both deals?  Should i just do one?  What am i missing or not thinking about?  my gut says just do one and see how it goes, and i'm a believer in going with your gut.  But, I'd appreciate the feedback.  Nobody in my circle of friends would be even considered close to a mustachian and can't relate to anything financial with me. 
« Last Edit: September 06, 2018, 10:06:20 PM by goodday,eh »

ysette9

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Pulling money out of the market now to lend hard money
« Reply #1 on: September 06, 2018, 10:01:16 PM »
There is no guaranteed 10% return so just throw that word out of your thinking entirely. What you are asking is how much of your money can you afford to lose without seriously impacting your FIRE timeline or your friendship. You may get lucky if you invest and make a killing; you may also lose whatever you put in or something in between. With friends and family I would only put in what I could comfortably call a gift without ending up resentful of things went south. That is well less than $100k in my book.

In summary, what you describe sounds incredibly risky to me and something that I would want no part of. If you do decide to do it, I’d advise minimizing your exposure as much as possible.

webguy

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Re: Pulling money out of the market now to lend hard money
« Reply #2 on: September 06, 2018, 11:30:05 PM »
If it were me I would do it. He seems legit based on the info you shared.

marty998

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Re: Pulling money out of the market now to lend hard money
« Reply #3 on: September 07, 2018, 02:10:04 AM »
First ranking mortgages over the properties and cap the LVR at 70% and you should be sweet on this one.

Though really, if you are his accountant, can't you just raise his tax advice fees a little bit? Some of the advice you give him must save him tens of thousands in tax... perhaps a modified profit share of that is better?

Also, what does your partner think of this? Always get the consent of your SO!

runbikerun

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Re: Pulling money out of the market now to lend hard money
« Reply #4 on: September 07, 2018, 02:10:43 AM »
You're considering pulling a quarter of your holdings out of the market for fear of a downturn in the next twelve months, to invest in a single local market, in precisely the asset class that imploded so spectacularly a decade ago.

If you really want to try timing the market, push money into countercyclical stocks and government bonds. If you really want to get into property investment, go small scale or push money into an REIT. If you really want to push substantial sums into specific properties, don't do it with a guy who's willing to pay 10% to you to avoid dealing with a bank.

bwall

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Re: Pulling money out of the market now to lend hard money
« Reply #5 on: September 07, 2018, 05:19:13 AM »
Hard money lending is incredibly difficult. You have to be able to knee-cap someone, if not literally, then with paperwork through a lawyer.

Questions:
1) Can you foreclose if the loan isn't repaid? Are you familiar with that process in Florida?
2) Are you prepared to foreclose on a property?
3) Who will record your senior lien? (I hope the answer is that you will do it personally)
4) What happens to the unpaid interest, etc. in the event of a foreclosure?
5) Will you be able to confirm that the property is insured?
6) Are you OK with losing him as a client?

reeshau

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Re: Pulling money out of the market now to lend hard money
« Reply #6 on: September 07, 2018, 06:18:39 AM »
All good answers so far.  To which I would add:  you are looking to exchange long-term capital gains (probably) for interest, and therefore get it taxed at your income tax rate.  I don't have to tell an accountant that, but as you quote 10%, remember to de-rate that for the after-tax amount, if you are comparing the two.

RWD

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Re: Pulling money out of the market now to lend hard money
« Reply #7 on: September 07, 2018, 07:01:12 AM »
All good answers so far.  To which I would add:  you are looking to exchange long-term capital gains (probably) for interest, and therefore get it taxed at your income tax rate.  I don't have to tell an accountant that, but as you quote 10%, remember to de-rate that for the after-tax amount, if you are comparing the two.

I was going to mention the tax thing too. When I did hard money loans I was getting 11.5% but after taxes it was more like 8%.

I also didn't like that I needed a lot of cash sitting idle while waiting for an investment opportunity of unknown size to become available. So considering that I often needed to wait a few months a year between investments and not all the cash can be invested at once that 8% becomes more like 5-7% annualized return. Suddenly not looking so hot compared to stocks (and remember I was even loaning at 11.5%, not the above 10%).

There have been some previous discussions on this topic on the forums:
https://forum.mrmoneymustache.com/real-estate-and-landlording/what-are-the-risks-of-hard-money-lending/
https://forum.mrmoneymustache.com/investor-alley/investing-with-a-local-developer/

Cpa Cat

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Re: Pulling money out of the market now to lend hard money
« Reply #8 on: September 07, 2018, 07:29:31 AM »
Hard money lending has high interest rates for a reason. I would want more than 10%.

I think RWD's post illustrates why:

I was going to mention the tax thing too. When I did hard money loans I was getting 11.5% but after taxes it was more like 8%.

I also didn't like that I needed a lot of cash sitting idle while waiting for an investment opportunity of unknown size to become available. So considering that I often needed to wait a few months a year between investments and not all the cash can be invested at once that 8% becomes more like 5-7% annualized return. Suddenly not looking so hot compared to stocks (and remember I was even loaning at 11.5%, not the above 10%).

Lack of liquidity.
Taxes.
Risk.

Not only does the return not look comparably good to the market at 10% interest, but you have the added possible legal cost of foreclosing (I assume you plan to have a lien on the property, too).

But I don't think you're an idiot for considering it. Just follow the same thought process as a mortgage lender - get a contract, lien on the property, require proof of insurance on the asset, check each year to make sure the property taxes are being paid, consider doing a credit check, too. Then build the costs of all of the above into your required rate of return,

talltexan

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Re: Pulling money out of the market now to lend hard money
« Reply #9 on: September 07, 2018, 07:32:16 AM »
It seems that you have an opportunity, and your willingness to do business with a friend depends on the relationship.

The fact that you do his taxes is nice: he's only one of many clients there, right? 

I would go into this having an understanding as to the limit of my net worth that was in deals of this type. 25% of NW in one real estate market sounds like too much exposure to me, particularly if you own a home in that area already.

Miss Piggy

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Re: Pulling money out of the market now to lend hard money
« Reply #10 on: September 07, 2018, 07:36:37 AM »
You do his taxes...on your own/self-employed, or through an employer that you work for? If through an employer, I'd be surprised if your employer allowed such relationships/lending. In the U.S., I think most money-related employers would forbid this type of transaction between employees and clients.

Retire-Canada

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Re: Pulling money out of the market now to lend hard money
« Reply #11 on: September 07, 2018, 08:35:17 AM »
So, back to the question.  Am I an idiot for considering this at all?  Am I an idiot for not jumping on both deals?  Should i just do one?  What am i missing or not thinking about?  my gut says just do one and see how it goes, and i'm a believer in going with your gut.  But, I'd appreciate the feedback.  Nobody in my circle of friends would be even considered close to a mustachian and can't relate to anything financial with me.

I wouldn't touch a deal like that with a ten foot pole. The [il]logic you are using to justify going from the market to a much more risky poorly diversified investment is scary. You are 7yrs away from FIRE don't fuck it up.

goodday,eh

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Re: Pulling money out of the market now to lend hard money
« Reply #12 on: September 07, 2018, 10:17:21 AM »
lots of great input.  Thanks. 

I've definitely been talked out of doing two deals.  I think I knew that was too risky or i wouldn't even posed the question. 

I'm going to look at the first property with him this weekend and keep mulling it over a bit.  It looks like he's buying the property for $40k and estimates $40k in repairs.  So, the amount i would lend would be $80k.  Similar homes are selling for $140k to $160k and rent for around $1,250 a month.  So, the math works there.

I'll answer a few of the questions here rather than responding to each post directly.

We will have a formal loan agreement and lien in place. I will stipulate that the property is insured, but I also know that he has insurance on all of his properties so that's SOP for him.

My wife is on board with one deal, but was hesitant on doing 2.  So, all more the reason not to move forward with the second one.

I own my CPA firm and i'm not worried about the client relationship.  It wouldn't impact me financially at all.  I'd be more worried about the friendship, but unless he did something fraudulent I don't think it would.  Business is business and i know i'm taking a risk.

As far as % of NW, I do have significant equity in my home (i know still real estate related) and the value of my firm.  So, a $100k loan would be closer to 7%. 

I do understand the tax implications, but think a 7-8% after tax return will be better than what the market will produce in the next 2 years. 

I guess what it comes down to for me, is that I just have a lot of market anxiety right now.  Between the political unrest, student loan bubble, and dismal savings rate, something is going to burst.  While I don't want to try to time the market and keep it in cash, i think this is an approach that allows me to relieve some of that anxiety while still getting a decent return.

It feels like i'm standing in front of somebody and i know i'm about to get punched.  I'd like to duck.






goodday,eh

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Re: Pulling money out of the market now to lend hard money
« Reply #13 on: September 07, 2018, 10:20:21 AM »
You are 7yrs away from FIRE don't fuck it up.

i like this line.  despite what i just wrote, it keeps getting repeated in my head and could win out.


RWD

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Re: Pulling money out of the market now to lend hard money
« Reply #14 on: September 07, 2018, 11:13:59 AM »
I do understand the tax implications, but think a 7-8% after tax return will be better than what the market will produce in the next 2 years.

But it is not 7-8%, it is lower. You need to account for the time when your money is not invested. There is a delay in getting money invested. There is downtime between loans. The amount for an available loan might not match the full amount you have sitting waiting to be invested. You could be paid back early which adds another cycle of overhead earlier than anticipated. And all of that assumes that nothing goes wrong with the deals.

In my case I made myself available for hard money loans for a little over two years. Because of how much money I had to set aside to be available for the next loan my effective annual yield (on 11.5%) after idle time and taxes was about 4.2%! After inflation for that period my real return was 2.7%... Inflation adjusted returns for the SP500 for the same period was 20.2%. Now I'm depressed that I ran these calculations...

Rob_bob

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Re: Pulling money out of the market now to lend hard money
« Reply #15 on: September 07, 2018, 01:39:21 PM »
10 years ago I made a 15 year loan at 5.25% to a friend for the down payment on a couple of rentals.  He paid it off recently to simplify his finances because of an impending divorce.  It worked out okay but I wouldn't do 25% of NW.

YMMV.

reeshau

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Re: Pulling money out of the market now to lend hard money
« Reply #16 on: September 08, 2018, 02:56:34 PM »
@goodday,eh  it certainly seems like you are going into this with your eyes open.  Return vs. stocks really doesn't matter, if you are worried about the market.  Worry could cause you to panic, and make a stupid decision.  If this helps you relax, and doesn't f-up your FIRE plans, then it seems OK for you.

It seems that, while you are trading out of stocks, this really is a bond.  (and, of course, it *is* fixed income; we all have just been comparing the opportunity cost)  This is exactly the role of bonds in a portfolio.  But, market theory would say you are taking unnecessary (and unrewarded) risk because of a lack of diversification.  What you have to address that is your own legwork and knowledge of your client / friend.  Nobody else can judge that for you.

runbikerun

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Re: Pulling money out of the market now to lend hard money
« Reply #17 on: September 08, 2018, 03:21:50 PM »
You mention that you're worried about the student loan bubble: isn't the University of South Florida one of the largest employers in your region? If there's a severe shock in the tertiary education sector, Tampa real estate will be a bigger risk than almost anything else.

Goldielocks

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Re: Pulling money out of the market now to lend hard money
« Reply #18 on: September 08, 2018, 03:41:09 PM »
Well, I am not as concerned as the other people on here.

For 10%
-Can you get a first position mortgage on the property (with you as the mortgage provider)?   What is the loan to value?  Should be about 75% or less for only 10% per year rate.
-Do you have a place / strategy to reduce the taxes on it?  Is it accrued as interest each year (you pay tax each year like bond interest) or taxed at the end like a capital gain?  A simple mortgage or a loan nomally is accrued and taxes paid each year.  OR, is this a partnership (complex) deal? Can you loan the money from within your pre-tax account so the income is not taxed until you withdraw the money (RRSPs in Canada would be ok with that).

- are you repaid only when the home sells or from other income/ investments?  e.g., do you want your loan interest to be paid from all the doors that your friend manages, (although the mortgage is only on one), or do you want it to be based solely on the success of a single property .. e.g. what happens if there is a bad tenant or issue with this property yet your friends' business overall is strong?

tralfamadorian

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Re: Pulling money out of the market now to lend hard money
« Reply #19 on: September 09, 2018, 11:26:44 AM »
I'm not as bearish on this as the others especially given your updated numbers- $40k purchase, $40k rehab, $1250 rent. 10% is pretty good for private money. Make sure 1) you're first lien, 2) that the lien is registered, 3) that you're on the insurance and 4) in the worst scenario, you are comfortable taking ownership of the property via foreclosure.

Personally, I wouldn't be comfortable lending this late in the cycle but if you can verify the numbers given via an additional source to your friend, the investment's income and ARV should be able to weather a significant down swing.

FrugalSaver

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Re: Pulling money out of the market now to lend hard money
« Reply #20 on: September 09, 2018, 10:05:18 PM »
10 years ago I made a 15 year loan at 5.25% to a friend for the down payment on a couple of rentals.  He paid it off recently to simplify his finances because of an impending divorce.  It worked out okay but I wouldn't do 25% of NW.

YMMV.

How did you handle taxes on this interest made on the loan to your friend?

swannyboy

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Re: Pulling money out of the market now to lend hard money
« Reply #21 on: September 10, 2018, 02:32:41 PM »
In 2006 I lent one of my best friends of more than 12 years, 70K for a business venture.  I had some cash I wanted to invest and I thought that investing in a trusted friend would be the way to go.  He never made a single payment back.  I later learned he had taken money from other friends for different investments and was running his own personal Ponzi type scheme.  He did not start out trying to scam anyone, he just made some bad investments and borrowed from Peter to pay Paul.  As he got deeper and deeper in, he kept borrowing from people while waiting for everything to correct itself.  It turns out the loan from me was to pay others he had fallen behind in payments too.  I never got a dime back.  At one point we went to an arbitrator and agreed to a VERY generous (to him) payment schedule, which he also flaked on. 

Lessons learned.  I don't invest money in friends.  It is virtually impossible to collect anything if they decide they are not going to pay it back.  You really see another side of people when they owe you money.  Any bump in the road and the friendship is over and your money is gone.

goodday,eh

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Re: Pulling money out of the market now to lend hard money
« Reply #22 on: September 10, 2018, 11:09:20 PM »
a bit of an update.

My friend offered (unsolicited) to secure the note with another property he owns outright as well as the property he is purchasing.  The final loan will be $75k as he negotiated the property down a bit before closing.  The LTV (including the collaterized property) is now over 100%.  I've had my attorney (who is also a client and did it as a favor) review the contracts and the title search on both properties.  Everything is good there.

Despite all the warnings (which I really do appreciate), i'm going to do just the one deal.  I will receive the 10% interest only payments for 12 months and then the rate will adjust to 12%.  I suspect he'll refinance out before then and i'll move it back it in the market.  My expectation is that it will be 9 months before he'll have it ready to refi and then can close. 

my decision really boils down to a couple of factors.

1. I really trust this guy.  Honestly, I had thought about doing hard money deals with other people once i got comfortable with the transaction, but this thread has convinced me not to do that.  But, he's a bit different.  He's a close friend and i also know pretty much everything about his personal finances (i even have access to his online banking) which is a unique advantage. 

2. The deal is well secured so that even if my yield isn't what i want or expect, i won't lose it all.

3. I'll consider it a learning experience.  I'm trying to learn other ways to earn a yield on money as I don't want to rely on a 4% drawdown for life.  Though, i'm not sure this will be a future path for my investments.

The idle time is something i hadn't completely considered when making this decision (though i watched the market today right after I sold), so I really appreciate that input.  I don't like holding cash and i know you don't want to miss the biggest days in the market.  However one of the primary reasons i'm making the decision now, is that i don't mind being idle just a bit for the next 12 months.  as long it's not in cash.   Going forward, i think this may be the biggest reason to avoid these type of alternative investments.  But right now, I like having a small hedge.  I could be wrong on my fears, and we can all laugh at me 12 months from now, but if i earn 6% to 8% on a small portion of my investments and the market keeps climbing, i'll live with that. 

I expect the hard money loan to be a one time thing.  Hopefully not because it was painful.

I'll certainly do an update if it all goes to shit or if it all works out.

Really appreciate everyone's thoughts and opinions.  It's crazy to me that i can't have these conversations with friends and family, but i can with people on the internet.  But, that's where I am.

Cache_Stash

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Re: Pulling money out of the market now to lend hard money
« Reply #23 on: September 11, 2018, 05:49:52 AM »
One of my many rules:

Never lend money to family or friends unless you are willing to part with the money on charitable terms.

ChpBstrd

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Re: Pulling money out of the market now to lend hard money
« Reply #24 on: September 11, 2018, 09:41:18 AM »
Good luck!

My risk tolerance is more along the lines of sifting through the thousands of publically traded companies with ROE over 10%, then writing put options to earn my 10%, often without even buying them.

Expect to find yourself thinking about real estate bubbles and rising interest rates more often than you did before. Also expect to find yourself examining your friend's behavior more than before (Are we spending as much time together? Is he cheerful?). The psychology in this deal will be brutal.

catccc

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Re: Pulling money out of the market now to lend hard money
« Reply #25 on: September 11, 2018, 10:32:04 AM »
If you are interested in diversifying with hard money lending, there are non-friend ways to do this.  Peer Street comes to mind, but you need to be an accredited investor (NW over $1M excluding real estate, or income over... IDK 200K or 300K?)  I think there are similar outfits for non-accredited investors, maybe realty shares?  There are probably others out there, too.

goodday,eh

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Re: Pulling money out of the market now to lend hard money
« Reply #26 on: September 11, 2018, 10:34:29 PM »
Good luck!

My risk tolerance is more along the lines of sifting through the thousands of publically traded companies with ROE over 10%, then writing put options to earn my 10%, often without even buying them.

Expect to find yourself thinking about real estate bubbles and rising interest rates more often than you did before. Also expect to find yourself examining your friend's behavior more than before (Are we spending as much time together? Is he cheerful?). The psychology in this deal will be brutal.

I think because it's a short term deal and he can afford my payments based on his salary alone, i'll avoid overanalyzing his mood.  Until a payment is late, right? 

I do understand the examining behavior as i've experienced it in reverse.  I know when clients see me out at dinner, etc. when i haven't completed their returns, their wondering why i'm not in the office finishing them up.  But, i'm going in with eyes wide open.  I know the risk.  i'm just willing to take it this one time. 

84Blazer909

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Re: Pulling money out of the market now to lend hard money
« Reply #27 on: September 13, 2018, 10:08:03 AM »
hey folks! - first time poster.  This topic made me register because I feel like it's right up my alley.

My Background  - I've purchased four rental properties myself (in SoCal where they're a lot more than 40k), all personal funds, cash flow is terrific on all of them.

Couple issues I see here:


1.  You can trust a friend and know they won't screw you over, that's one thing.  But sometimes the trusted friend just *can't* get you back the way you wanted (even though they intend to). It could get dragged out long enough that you'll be in limbo and never want to foreclose. Felt this with loaning money to friends myself (in my circle I'm the "wealthy" one ha).

2.  He's saying he doesn't want to deal with the lenders (it's a hassle, totally understand), but per the plan he still has to ReFi later to get your money, so he's still dealing with a bank (Yes, cash ReFi's are a bit easier).  As my point below -why can't he come in 50% with 40k of his own funds if he doesn't like lenders??

3. All your own cash to the table - So you get 10% and he doesn't have to put in a *dime*?  He should have *some* skin in the game, it shouldn't be that hard for him to gather 40k of his own money (like from the last ReFi!!)  With my properties I can come up with 40k out of the equity very easily.  Shouldn't be that big of a deal for him either.

4. As others have posted, that is a huge % of your overall net work on an investment you've never done before. Why not start small and learn the game first? What's the rush? You can move your stock capital into something safer.  Real Estate is a long term game.

Conclusion: I'm not saying "Don't do it". Just start with a smaller % of your net worth (best to diversify among multiple hard money loans anyway) and make sure he has to put in some cash of his own.  If he doesn't have any, then there's something wrong.  If he doesn't want to then he must not be fully confident his new investment. My .02


« Last Edit: September 13, 2018, 10:15:56 AM by 84Blazer909 »

Goldielocks

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Re: Pulling money out of the market now to lend hard money
« Reply #28 on: September 13, 2018, 04:06:37 PM »
Welcome 84Blazer909.  Great post.  I
 look forward to seeing more on other threads, too.

84Blazer909

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Re: Pulling money out of the market now to lend hard money
« Reply #29 on: September 14, 2018, 09:27:20 AM »
Thanks! Glad to finally jump in :)

rob in cal

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Re: Pulling money out of the market now to lend hard money
« Reply #30 on: September 14, 2018, 09:55:04 AM »
  If I was going to do hard money lending it would be through a hard money loan fund, like Broadmark which IIRC has first position loans with low ltv's, staggered distribution of loan amount (as the work gets done, not all at once to the builder) and I believe loans only in non-judicial states where its easier to take possession of property if needed.  I'd actually invest a bit with them if I was accredited, which I'm not yet, though could be if I got a heloc which I don't really want to do at this point.

BigHaus89

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Re: Pulling money out of the market now to lend hard money
« Reply #31 on: September 14, 2018, 12:25:22 PM »
Wow, a lot of very risk adverse people here. You might get better advice at a forum more oriented toward real estate investing.

This sounds like a potentially good venture to invest in. You might do well to talk to a lawyer that specializes in business law/real estate and learn more from them. I would start there.

RWD

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  • Posts: 3490
  • Location: Mississippi
Re: Pulling money out of the market now to lend hard money
« Reply #32 on: September 14, 2018, 12:48:15 PM »
Wow, a lot of very risk adverse people here. You might get better advice at a forum more oriented toward real estate investing.

This sounds like a potentially good venture to invest in. You might do well to talk to a lawyer that specializes in business law/real estate and learn more from them. I would start there.
Multiple people in this thread have experience with hard money lending, including myself. I wasn't adverse to the risk. I just wasn't impressed with the returns even when everything went right.